Directors and Personal Liability – Tips to reduce the risk

This article provides a summary of the types of liability a Director may face, and practical tips to avoid personal liability where possible.

Company Directors are typically classified as an “at-risk” individual, because they are at risk of personal liability stemming from their duties and obligations as a Director.

Director Duties and Obligations

Company Directors, Company Secretaries and in some circumstances executives and other people who control the way a Company operates (also known as shadow Directors or de facto Directors) owe duties and responsibilities to the Company and its Shareholders. These duties arise under the Corporations Act 2001 (Corporations Act), the common law and any Shareholders Agreement, Constitution or Executive Employment Contract.

Directors are generally responsible for running the day-to-day activities of a Company, including its business. The duties owed by Directors to a Company extend beyond the normal fiduciary duties of a senior employee to an employer as the Corporations Act and relevant WH&S legislation, impose legal obligations upon Directors, including:

  1. ensuring proper financial records are kept;
  2. ensuring the Company can pay its debts and does not trade whilst insolvent;
  3. understanding what the Company is doing at all times;
  4. acting in the best interests of the Company;
  5. acting in good faith and for a proper purpose;
  6. not improperly using their position to gain an advantage for themselves or cause detriment to the Company;
  7. not improperly using information gained from their role; and
  8. ensuring compliance with Work Health & Safety Laws, including the due to exercise due diligence.

Some examples of breaches of the duties above include:

  1. failing to disclose all relevant documents to the board of Directors;
  2. promoting personal interests above those of the Company;
  3. diverting a business opportunity away from the Company;
  4. failing to disclose all relevant documents to the board of Directors;
  5. allowing a Company to incur a debt when it is insolvent.

What happens if a Director breaches their duties or obligations?

If a Director is found to have breached their duties or obligations the Director may be personally liable for damages and fines. Directors also risk prosecution under the Work Health & Safety Act and even gaol time depending upon the severity of the breach.

An action for breach of a Directors’ Duty may be brought by the Company (including a Liquidator), by a Shareholder (with leave of the Court) or by ASIC.

Other Circumstances where Directors can be personally Liable

A Director may also be liable:

  1. in Liquidation where the Director has been a party to an insolvent transaction, including an unreasonable Director-related transaction and creditor-defeating dispositions;
  2. where the Company has failed to pay certain tax and superannuation obligations and the Director receives a Director Penalty Notice;
  3. where the Director has signed a Personal Guarantee and/or indemnity; and
  4. where the Director engages in misleading or deceptive conduct.

What is a Personal Guarantee and Indemnity?

In short, a personal guarantee is a promise to answer for a third party’s obligation.  Commonly, a creditor of a Company will seek a personal guarantee from the Director of that Company in relation to amounts owing by the Company to the creditor.  This arrangement ensures that a natural person is ultimately responsible for the debt of the Company.

A personal guarantee is often coupled with an indemnity in favour of the creditor where a person agrees to indemnify the creditor from any loss suffered by reason of the actions of a third party.

The obligations in a personal guarantee and those in an indemnity are different and result in a difference in the nature and extent of the obligations assumed.

In lay terms, where a Director signs a Personal Guarantee and the Company does not, or cannot, satisfy its obligations to the creditor, the creditor has a right to recover any loss from the Director. The Director will then be personally liable to the creditor for any amounts the Company owes to that creditor.

What is a Director Penalty Notice

Under the ATO’s Director Penalty regime company Directors can be personally liable for Company obligations. The Director Penalty regime applies to unpaid “PAYG” withholding amounts, Superannuation Guarantee Charge “SGC” obligations and GST liabilities.

The effect of the Director Penalty regime is that if a company of which a person is a Director fails to ensure that the company pays its PAYG withholding, SGC and/or GST liability obligations by the due dates, the Director becomes personally liable for a penalty equal to the unpaid PAYG withholding, GST or SGC amounts. These penalties are known as “Director Penalties”, read more in this article.

Further, section 558GA of the Corporations Act gives the Commissioner of Taxation a right to recover from Directors personally an amount of “loss or damage” resulting from a Liquidator successfully recovering from the Commissioner for Taxation payments which are ordered to be an unfair preference. This means that a Director can be personally liable to reimburse the ATO for payments that the Company made, which were clawed back by a Liquidator under the unfair preference regime of the Corporations Act, which may include payments that the Company makes to the ATO under a payment arrangement.

What is an Insolvent Transaction

A Director has an obligation to prevent insolvent trading under section 588G of the Corporations Act.

Insolvent trading occurs if, when incurring debts:

  1. the Company is or will become insolvent by incurring the debts; and
  2. there are reasonable grounds for suspecting that the Company is insolvent, or would become insolvent by incurring the debts.

A Director will be personally liable for insolvent trading if the Director was aware or suspected that the Company was or would become insolvent when it incurred the debts or a reasonable person standing in the Director’s shoes would have been so aware.

Practical Tips to Avoid Liability

The following is some practical tips to reduce your risk of personal liability:

  1. do not sign personal guarantees, or at least negotiate a cap on liability;
  2. put the Company’s interests before your own when making business decisions and understand that the Company is a separate legally entity and not an extension of your personal estate;
  3. do not make any promises to customers or other creditors about Company matters that may not be accurate or true, or could be misleading;
  4. engage an Accountant or Bookkeeper to maintain your financial records, including lodging all BAS and financial statements on time;
  5. have a separate bank account where money is automatically transferred into each month to enable you to pay all GST liabilities, PAYG withholding amounts and Superannuation Guarantee Charge on time;
  6. act promptly if a Director Penalty Notice is received; and
  7. promptly consult with an Insolvency Practitioner, including a Solicitor specialising in insolvency, if you have any concerns about the solvency of the Company as there are circumstances where certain personally liability can be avoided if action is taken promptly, for more information see our Safe Harbour Guide.

If you would like any specific advice on your personal liability as a Director, or to discuss your options if you do consider your company may be insolvent contact one of our Lawyers today.

Corporate and Commercial Lawyers for Sydney and Newcastle

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The information in this article is not legal advice and is intended to provide commentary and general information only. It should not be relied upon or used as a definitive or complete statement of the relevant law. You should obtain formal legal advice specific to your particular circumstance. Liability limited by a scheme approved under Professional Standards Legislation.

Solicitor Director
Accredited Specialist (Business Law)